What We Talk about When We Talk about Voting: Efficiency and the Error in Empty Voting

Article excerpt

INTRODUCTION

In early 2001, Perry Corporation ("Perry"), a hedge fund, was a substantial shareholder of Rubicon Ltd. ("Rubicon").1 By June 2001, however, Perry publically announced that it had whittled down its sizeable investment to that below the threshold requiring disclosure.2 Surprisingly, a year later, Perry disclosed a sizeable holding in Rubicon conveniently in time to vote at Rubicon's annual meeting.3 Unbeknownst to Rubicon, Perry had previously engaged in derivatives transactions designed to decouple the economic interest of their shares from the attendant voting rights.4 Decoupled of its voting rights, Perry's holding diminished in size albeit temporarily. Then, before the annual meeting, Perry easily unwound its derivative transactions, reuniting the shares with their voting rights and consolidating its once again sizeable holding in time to influence the vote.5 In short, Perry had engaged in "decoupling," or the strategic separation of the right to vote from the economic ownership of shares.6

Decoupling has existed undocumented for an undetermined amount of time.7 Yet, in 2005, Shaun Martin and Frank Partnoy first identified situations in which investors used derivatives to vary their economic interests while retaining voting power, or engaged in decoupling practices.8 Next, Henry Hu and Bernard Black comprehensively discussed the phenomenon of decoupling in their seminal article, The New Vote Buying: Empty Voting and Hidden (Morphable) Ownership,9 Hu and Black referred to decoupling as the "new vote buying" because it consists of a combination of "conventional" transactions that are by themselves not suspect: the purchasing of shares and using derivatives for hedging purposes.10 The results, however, are anything but conventional."

For the decoupled investor who maintains voting rights but who has otherwise abrogated economic ownership, decoupling may have many benefits, chief among them personal profit.12 Corporate law rewards an interest in profit maximization so long as it is aligned with maximizing firm value.13 Under the shareholder primacy model of corporate law, shareholders are given the ability to vote on corporate decisions precisely because they are more tied to the economic risk in the venture.14 As the "residual claimants," they are interested in maximizing firm value more than any other corporate party.15 Shareholder votes are thus deemed efficient because their decisions will be directed at wealth maximization.16 The decoupled investor, on the other hand, has severed herself from the economic interest of her shares and is therefore not interested in maximizing the value of those shares.17 And despite her disinterest in wealth maximization, the decoupled investor still retains the right to vote on those shares-her votes are inefficient.18

This Note argues that the votes associated with decoupled shares should be excluded from corporate voting. To accomplish this, federal disclosure rules should require that investors disclose the extent of their shares that are decoupled in the event of a vote.19 Aware of the decoupled votes, the corporation can therefore exclude those from the final vote tally, curing the inefficiency problem by only counting those votes that are interested in maximizing firm value.20

This Note proceeds in three parts. Part I discusses the efficiency rationale underlying the shareholder primacy model, and how decoupling breaks the efficiency link in its various forms. Part II discusses the existing disclosure requirements, how decoupling evades those requirements, and critiques existing proposals to address decoupling. Part III describes the author's proposal to mandate the disclosure of decoupled shares on shareholder voting proxy cards and to exclude them from the vote.

I. SHAREHOLDER PRIMACY AS AN EFFICIENT MEANS OF WEALTH MAXIMIZATION

This part begins by exploring the shareholder primacy model and the crucial efficiency link between shareholders' interest in wealth maximization and their right to vote on corporate decisions. …